Is a Class Action Lawsuit Settlement Taxable?
We featured How to Find Class Action Settlements That Owe You Money last week to help you find current settlements you might be eligible for. I’ve had some luck with class action lawsuits in the past. As each post-card sized, class action plea comes in the mail, I fill it out and send it in. Then, I forget about it. Because let’s face it, how often does this sort of thing pan out?
Some class actions I’ve seen look pretty bogus, while others have had some huge impacts (such as the class action lawsuit brought by lots of merchants against some of the biggest credit card companies regarding credit card swipe fees).
Money I’ve Received
2011 was a great year for me as far as class action lawsuits are concerned. I filled out several, and received the following in return:
- $103.82 from H&R Block Inc.: In my early 20s I did not understand taxes too well. So even though I only had a basic tax return at that point, I went into the local H&R Block to get my taxes done. The woman suggested to me that if I were to open a traditional IRA for $2500 I would get back roughly $825. So I opened an Express IRA with them, my first retirement account ever! Since then I’ve learned much more about finances, retirement, and taxes, so I converted it many years ago to a Roth IRA, paid back the taxes, and moved it over to Vanguard. However, I received a check for almost the cost of having my taxes done because of this lawsuit, which alleged that H&R Block promoted and sold Express IRAs to its tax preparation customers as a good way to save money and earn interest, but the low rate of interest paid on Express IRAs and the various fees charged on the accounts meant customers often lost money on their investments.
- $10 from LifeLock: I was one of the millions of consumers who received a refund from LifeLock due to a class action lawsuit settled between them, the FTC, and 34 states. In this lawsuit it was alleged that the company used misleading advertising practices. While LifeLock guaranteed complete identity protection (do you remember those commercials where their CEO plastered his social security number across a city to indicate how trusting he was with the company?), when in fact it was found that the fraud alerts that LifeLock placed on customers’ credit files protected only against certain forms of identity theft.
Is a Class Action Lawsuit Settlement Taxable?
According to the IRS, “An award is generally taxable, unless it is specifically excluded from income by law or constitutes a return of capital.” Whether or not your class action lawsuit money is taxable depends upon the nature of the lawsuit and of several other factors.
For example, settlements paid out to shareholders are generally not taxable because they usually represent a return of your after-tax capital lost from some sort of share mismanagement. Settlements that are restitution for damages from physical injury that the payer caused are not taxed either.
However, if the taxpayer used the cost of medical treatment as a deduction in a previous tax year, then the money is taxable. If the injury was emotional in nature, then it had to have caused a physical injury in order for the money to not be taxable.
A settlement that involves a return of premiums paid for coverage is not taxable. This is considered a reimbursement or restitution. However, money received from punitive damages (damages issued in order to deter the party from engaging in the activity in the future that was the basis for the lawsuit) are taxable.
How Much is Taxable?
Another indicator that your class action settlement money is taxable is whether or not you receive a tax form at the end of the year. You should receive a 1099 at the end of the tax year. If you receive a 1099 MISC, then that means the entire amount, some of which can be for nontaxable damages, has been lumped together. If you received a 1099 INT, then the payer has only reported to the IRS what they think is a taxable payment to you.
Remember that the amount of taxes you ultimately pay depends on your tax bracket, tax deductions, and tax credits.
Class Action Lawsuits
As you can see from above, receiving money from a class action lawsuit can actually happen. It’s happened to me!
Have you received money from a class action lawsuit?
I read your article last week and I thought about the cards, letters, and such that I received over the years. I still have some in my file cabinet awaiting a resolution (how do you check on the resolution????). Anyway, a few nights ago, I was going thru some “junk mail” and what do I find…a check! A check related to a class action suit against TransUnion. (Funny, I didn’t have any cards, letters or such in my file cabinet for TransUnion..on well.)